Sunday, June 30, 2013

I'm still catching up and recovering from recent events, so I'll turn the
microphone over to Chris Dillow:

Immigration, Class, & Ideology: ...the effects of immigration take place in a class-divided society.
For those in power, the benefits - high profits - are quick and easy. But for
those at the bottom end of the labour market, they are
less pleasant.

But it needn't be so. Imagine our retailer were a full-blooded worker coop.
Workers would then think: "Isn't it great we don't have to that dangerous job
now, so we can do nicer jobs and get a share of higher profits". And if
redundancies are made, they'll be on better terms. (And of course, in a society
not disfigured by class division, unemployment benefits would be higher).

In this sense, it is obvious that immigration - insofar as it does worsen the
condition of some workers (which is easily overstated) - is a class issue.
Rather than ask: "why are immigrants taking my job?" Dave could equally ask:
"why are there class divisions which prevent the benefits of migration flowing
to everyone?"

So, why is one question asked when the other isn't? The answer is that
capitalist power doesn't just determine who gets what, but also what issues get
raised and which don't. As E.E.Schattschneider wrote in 1960:

Some issues are organized into politics while others are organized out.
(quoted in Lukes, Power:
A Radical View, p20)

In this way, it is immigrants who get scapegoated rather
than capitalists.

DSGE Models and Their Use in Monetary Policy: The past 10 years or so
have witnessed the development of a new class of models that are proving
useful for monetary policy: dynamic stochastic general equilibrium (DSGE)
models. The pioneering central bank, in terms of using these models in the
formulation of monetary policy, is the Sveriges Riksbank, the central bank
of Sweden. Following in the Riksbank’s footsteps, a number of other central
banks have incorporated DSGE models into the monetary policy process, among
them the European Central Bank, the Norge Bank (Norwegian central bank), and
the Federal Reserve.

This article will discuss the major features of DSGE models and why these
models are useful to monetary policymakers. It will indicate the general way
in which they are used in conjunction with other tools commonly employed by
monetary policymakers. ...

Friday, June 28, 2013

... Over the past year and a half, in the wake of Thomas Philippon and Ariel
Resheff's estimate that 2% of U.S. GDP was wasted in the pointless
hypertrophy of the financial sector, evidence that our modern financial
system is less a device for efficiently sharing risk and more a device for
separating rich people from their money--a Las Vegas without the glitz--has
mounted. Bruce Bartlett points to Greenwood and Scharfstein, to Cechetti and
Kharoubi's suggestion that financial deepening is only useful in early
stages of economic development, to Orhangazi's evidence on a negative
correlation between financial deepening and real investment, and to Lord
Adair Turner's doubts that the flowering of sophisticated finance over the
past generation has aided either growth or stability.

Four years ago I was largely frozen with respect to financial
sophistication. It seemed to me then that 2008-9 had demonstrated that our
modern sophisticated financial systems had created enormous macroeconomic
risks, but it also seemed to me then that in a world short of risk-bearing
capacity with an outsized equity premium virtually anything that induced
people to commit their money to long-term risky investments by creating
either the reality or the illusion that finance could, in John Maynard
Keynes's words, "defeat the dark forces of time and ignorance which envelop
our future". ...

But the events and economic research of the past years have demonstrated ...
I should ... have read a little further in Keynes, to "when the capital
development of a country becomes a by-product of the activities of a casino,
the job is likely to be ill-done". And it is time for creative and original
thinking--to construct other channels and canals by which funding can reach
business and bypass modern finance with its large negative alpha.

The war on coal won't cost jobs in a depressed economy, it "could be just
what our economy needs":

Invest, Divest and Prosper, by Paul Krugman, Commentary, NY Times: It
has been a busy news week, what with voting rights, gay marriage and Paula
Deen. Even so, it’s remarkable how little attention the news media gave to
President Obama’s new “climate action plan.”...; this is ... a very big
deal. For this time around, Mr. Obama wasn’t touting legislation we know
won’t pass. The new plan is, instead, designed to rely on executive action.
This means that ... it can bypass the anti-environmentalists who control the
House of Representatives.

Republicans realize this, and ... right now they don’t seem eager to attack
climate science, maybe because that would make them sound unreasonable
(which they are). Instead, they’re ... denouncing the Obama administration
for waging a “war on coal” that will destroy jobs.

And you know what? They’re half-right. The new Obama plan is, to some
extent, a war on coal — because reducing our use of coal is, necessarily,
going to be part of any serious effort to reduce greenhouse gas emissions.
But making war on coal won’t destroy jobs. In fact, serious new regulation
of greenhouse emissions ...

It’s always important to remember that what ails the U.S. economy right now
isn’t lack of productive capacity, but lack of demand. The housing bust, the
overhang of household debt and ill-timed cuts in public spending have
created a situation in which nobody wants to spend; and because your
spending ... this leads to a depressed economy over all. ...

Suppose that electric utilities, in order to meet the new rules, decide to
close some existing power plants and invest in new, lower-emission capacity.
Well, that’s an increase in spending, and more spending is exactly what our
economy needs.

O.K., it’s still not clear whether any of this will happen. Some of the
people I talk to are cynical..., believing that the president won’t actually
follow through. All I can say is, I hope they’re wrong.

Near the end of his speech, the president urged his audience to: “Invest.
Divest. Remind folks there’s no contradiction between a sound environment
and strong economic growth.” Normally, one would be tempted to dismiss this
as the sound of someone waving away the need for hard choices. But, in this
case, it was simple good sense: We really can invest in new energy sources,
divest from old sources, and actually make the economy stronger. So let’s do
it.

Slow inflation may sound like a good thing, but it’s not. Particularly not
now.

However:

Ben S. Bernanke ... and other Fed officials have shown relatively few signs
of concern lately. The Fed’s most recent policy statement, and its economic
projections, both released last week, show that Fed officials expect the
pace of inflation to increase gradually. ...

“There are a number of transitory factors that may be contributing to the
very low inflation rate,” Mr. Bernanke said last week. “For example, the
effects of the sequester on medical payments, the fact that nonmarket prices
are extraordinarily low right now. So these are some things that we expect
to reverse and we expect to see inflation come up a bit. If that doesn’t
happen, we will obviously have to take some measures to address that. And we
are certainly determined to keep inflation not only — we want to keep
inflation near its objective, not only avoiding inflation that’s too high,
but we also want to avoid inflation that’s too low.”

If they "want to avoid inflation that’s too low," they should be doing more
about it now instead of coming up with reasons, yet again, to wait and see. Why
not say, for example, we'll do more now, and if it turns out we overshoot our
target a bit due to medical prices going up, "we will obviously have to take
some measures to address that."

But let me note that Landsburg’s latest unfortunate intervention follows a
well-trodden path: that of starting from the proposition that Keynesians are
themselves really, really stupid — a proposition argued not by pointing to
anything actual Keynesians say, but instead by presenting a caricature that
supposedly is what Keynesians believe. Call it Karicature Keynesianism.

Anyone who’s followed the various attacks on yours truly knows what I mean:
Keynesians believe that budget deficits never matter, that increasing demand
can solve all economic problems, that there’s no such thing as a supply side
to the economy, that more spending is always good. You can see it even in
the comments to Kuehn’s post, with people expressing doubt about whether
there’s crowding out in my textbook. Let me suggest a very difficult
research project: how about actually looking at the book?

Now, to some extent Karicature Keynesianism involves extrapolating what
people like me say about policy in a depressed economy with interest rates
up against the zero lower bound and pretending that this is what we say in
all situations. But where’s this urge to caricature coming from?

I’d say that it’s actually a form a flattery. If Keynesians had made a lot
of bad predictions in recent years — if inflation or interest rates had
soared, if austerity had produced prosperity — the other side could go after
what we actually said and say. But reality, it turns out, has a well-known
Keynesian bias. So the people who’ve gotten everything wrong are reduced to
attacking an economic doctrine that has worked pretty well by
misrepresenting that doctrine, and claiming that it’s stupid and absurd. ...

Let me follow-up on the point about predictions. A relatively well known economist who recently started a blog said he has a
formula for getting things right -- just take the opposite side of Krugman on any issue ("to take the correct stand on any issue I need only learn Krugman's, and take the opposite").
What's remarkable about his statement is that Krugman
got it basically right. Not in every instance or every detail,
but far, far more than most.

So what we have is someone who is supposed to be a credible voice implicitly telling
readers to believe those who were wrong over those who were right (or at least be dismissive of someone who is telling them things they need to know). Why? Because
his team disses Krugman. That's what they do. He was probably trying to impress the people in this group, get a little chuckle for his witty (?) remark by playing the bash Krugman game. He and others are
supposed to be these data based, scientist types -- that's how they portray
themselves -- but the truth is that many of them are anything but. It's a sad
reflection of our profession.

... I find it surprising that those who argued that QE had very little effect in
the economy are now ready to blame the central bank for all the damage they
will do to the economy when they undo those measures. So they seem to have a
model of the effectiveness of central banks that is very asymmetric - I
would like to see that model. ...

Real gross domestic product ... increased at an annual rate of 1.8 percent
in the first quarter of 2013 (that is, from the fourth quarter to the first
quarter), according to the "third" estimate released by the Bureau
of Economic Analysis. ... The downward revision to the percent change in
real GDP primarily reflected downward revisions to personal consumption
expenditures, to exports, and to nonresidential fixed investment that were
partly offset by a downward revision to imports.

Personal consumption expenditure growth was revised down from a 3.4%
annualized rate in the 2nd estimate to 2.6% in the 3rd estimate of GDP.
...

The current FOMC forecast is for GDP to increase between 2.3% and 2.6% from
Q4 2012 to Q4 2013. The first quarter was below the FOMC projections..., and it
appears the second quarter will also be below the FOMC forecast - if so, then
GDP will have to pickup in the 2nd half of 2013 for the Fed to start tapering
QE3 purchases in December.

... I meant the moral to be that revolutions only effect a radical
improvement when the masses are alert and know how to chuck out their
leaders as soon as the latter have done their job. ... If people think I am
defending the status quo, that is, I think, because they have grown
pessimistic and assume that there is no alternative except dictatorship or
laissez-faire capitalism. ... What I was trying to say was, “You can’t have
a revolution unless you make it for yourself...

Tuesday, June 25, 2013

This is from Joseph P. Joyce, the author of The IMF and Global Financial
Crises; Phoenix Rising?, which was published last year by Cambridge
University Press. The book examines the evolution of the policies and programs
of the IMF with respect to the global financial markets and crises in these
markets:

Among the many surprising features of the global financial crisis of 2008-09
was the emergence of the International Monetary Fund (IMF) as a leading
player in the response to what has become known as the “Great Recession.”
The news that the IMF was “back in business” was remarkable in view of the
deterioration of the IMF’s reputation after the crises of the late 1990s and
the decline in its lending activities in the succeeding decade. The IMF had
been widely blamed for indirectly contributing to the earlier crises by
advocating the premature removal of controls on capital flows, and then
imposing harsh and inappropriate measures on the countries that were forced
by capital outflows to borrow from it. Moreover, the IMF initially had no
direct role in dealing with the crisis. The IMF was relegated to the
sidelines as government officials in the advanced economies coordinated
their responses to the crisis.

All this changed in the fall of 2008, however, when the collapse of the
financial system led to an economic contraction that spread outside the
original group of crisis countries. World trade fell and capital flows
slowed and in some cases reversed, as nervous banks, firms and investors
sought to reallocate their money to safer venues. In response, the IMF
provided loans to a range of countries, including the Ukraine, Hungary,
Iceland, and Pakistan. In addition, the IMF restructured its lending
programs, cutting back on the policy conditions attached to its loans and
increasing the amount of credit a country could obtain. The Fund also
introduced a new credit line without conditions for countries with records
of stable policies and strong macroeconomic performance. Moreover, the IMF
pledged to work with national governments and other international
organizations after the crisis receded to continue the economic recovery and
improve the regulation of global financial markets. Consequently, many
commentators hailed the rejuvenated IMF as a “phoenix”.

The IMF’s response to the Great Recession marked a significant break from
its policies during previous global financial crises. These had taken place
during an era when the IMF’s membership was stratified by income and whether
or not a country borrowed from the Fund. In addition, the IMF had actively
encouraged the deepening and widening of global finance. The IMF’s previous
responses to financial crises, therefore, reflected the dominance of its
upper-income members as well as an ideological consensus in favor of
financial flows.

The crisis hastened the end of those conditions. The shock to global
financial markets and economies originated in the upper-income countries,
and the recovery of many of these nations has been relatively sluggish. The
emerging economies, on the other hand, rebounded from the global economic
contraction more quickly, which in turn contributed to the recovery of the
developing nations. Moreover, the crisis demonstrated that financial
instability can be a systemic condition, confirming the need for prudent
oversight and the regulation of financial markets and capital flows.

But while the Great Recession provided the IMF with an opportunity to
demonstrate that it has learned the lessons of its past mistakes, there are
fundamental economic and political transformations underway which will
affect the ability of the IMF to counter future financial instability. The
replacement of the dominance of the G7/8 by the G20 should lead to a more
equitable governance structure within the IMF, but inertia has slowed the
pace of reform. Moreover, the European debt crises pose new challenges to
the IMF. The Fund is caught in the crossfire among Eurozone governments and
their citizenries over how to deal with insolvent sovereign members. New
fiscal challenges will arise in other advanced economies with aging
populations and mounting health care and public pension costs, and the IMF’s
response will be scrutinized by its emerging market members who are
concerned about the scale of its lending.

Highway Robbery for High-Speed Internet, by Paul Waldman, American Prospect:
If you're one of those Northeastern elitists who reads The New York Times,
you turned to the last page of the front section Friday and saw an op-ed from
a Verizon executive making the case that "the United States has gained a
global leadership position in the marketplace for broadband"... "Hey," you might have said. "Didn't I read an
almost identical op-ed in the Times just five days ago?" Indeed
you did, though that one came not from a telecom executive but from a
researcher at a telecom-funded think-tank.
And if you live in Philadelphia, your paper recently featured this
piece from a top executive at Comcast, explaining how, yes, American
broadband is the bee's knees.

That smells an awful lot like a concerted campaign to convince Americans not
to demand better from their broadband providers. ... The telecoms are right about one thing: In the last few years, broadband
speeds have improved. ... But we're paying for what we get—oh boy, are we
ever paying. ...

How did it come to this? ... Susan Crawford, a Harvard professor and author
of Captive Audience: The Telecom Industry and Monopoly Power In the New
Gilded Age, puts the blame on the situation that the cable and telecom
companies have so purposefully engineered. "As things stand," she has
written, "the U.S. has the worst of both worlds: no competition and no
regulation." ... In many places, the local cable monopoly is the only realistic choice you
have for internet service...

With growing demand for video, online games, and other bandwidth-sucking
uses, ISPs have no choice but to keep increasing the speed of their service.
But they're in a position to make sure that we keep paying through the nose
for it. In other countries, costs have been kept down in large part because
they treat broadband like a utility. We have special rules for things like
water and electricity, both because they are absolutely vital to modern
existence and because of the impracticality of having too many competing
providers in any one geographical area. But in exchange for their monopoly
position, companies like Pepco or Con Edison are subject to tight regulation
to make sure they don't gouge their customers. Today's cable companies, on
the other hand, enjoy all the benefits of their monopolies (or in some
places, duopolies), with little of the regulatory oversight. As long as
that's true, broadband won't get any cheaper.

Monday, June 24, 2013

Paul Krugman:
Dead-enders in Dark Suits: ... Part of what makes the report so awesome
is the way that it trots out every discredited argument for austerity, with
not a hint of acknowledgement that these arguments have been researched and
refuted at length ...

Antonio Fatas:
BIS: Bank for Inconsistent Studies: ... Yet another day when one feels
that this crisis has been a wasted crisis for economists to learn about our
mistakes. ...

Simon Wren-Lewis:
The intellectual bankruptcy of the austerians: ... It is both amusing
and tragic to watch the advocates of fiscal austerity try and deal with the
fact that the thin intellectual foundations for their approach have crumbled
away, while at the same time the empirical evidence of their folly
accumulates ...

Why is the Fed talking about returning to normal monetary policy even though unemployment is still a huge problem?:

Et Tu, Bernanke?, by Paul Krugman, Commentary, NY Times: For the most
part, Ben Bernanke and his colleagues at the Federal Reserve have been good
guys in these troubled economic times. They have tried to boost the economy
even as most of Washington seemingly either forgot about the jobless... You
can argue — and I would — that the Fed’s activism, while welcome, isn’t
enough, and that it should be doing even more. But at least it didn’t lose
sight of what’s really important.

Until now.

Lately, Fed officials have been issuing increasingly strong hints that ...
they are eager to start “tapering,” returning to normal monetary policy. ...

The trouble is that this is very much the wrong signal to be sending given
the state of the economy. We’re still very much living through what amounts
to a low-grade depression — and the Fed’s bad messaging reduces the chances
that we’re going to exit that depression any time soon. ...

Sure enough,
rates have shot up since the tapering talk started..., and ... higher
rates will surely mean a slower recovery...

Fed officials surely understand all of this. So what do they think they’re
doing?

One answer might be that the Fed has quietly come to agree with critics who
argue that its easy-money policies are having damaging side-effects, say by
increasing the risk of bubbles. But I hope that’s not true, since whatever
damage low rates may do is trivial compared with the damage higher rates,
and the resulting rise in unemployment, would inflict.

In any case, my guess is that what’s really happening is a bit different:
Fed officials are, consciously or not, responding to political pressure.
After all, ever since the Fed began its policy of aggressive monetary
stimulus, it has faced angry accusations from the right that it is
“debasing” the dollar and setting the stage for high inflation... It’s hard
to avoid the suspicion that Fed officials, worn down by the constant
attacks, have been looking for a reason to slacken their efforts, and have
seized on slightly better economic news as an excuse. ...

It’s sad and depressing, in both senses of the word. The fundamental reason
our economy is still depressed after all these years is that so many policy
makers lost the thread, forgetting that job creation was their most urgent
task. Until now the Fed was an exception; but now it seems to be joining the
club. Et tu, Ben?

Sunday, June 23, 2013

A few comments on dumb policy: Please excuse my frustration ... there are
frequently honest disagreements on policy, but occasionally there are policies
that are almost universally panned. An example of a recent dumb policy ...[and
more] ...

Saturday, June 22, 2013

I need a quick post today, so I'll turn to the most natural blogger I can think of,
Paul Krugman:

Debased Economics: John Boehner’s
remarks on recent financial events have attracted a lot of unfavorable
comment, and they should. ... I mean, he’s the Speaker of the House at a
time when economic issues are paramount; shouldn’t he have basic familiarity
with simple economic terms?

But the main thing is that he’s clinging to a
story about monetary policy that has been refuted by experience about as
thoroughly as any economic doctrine of the past century. Ever since the Fed
began trying to respond to the financial crisis, we’ve had dire warnings
about looming inflationary disaster. When the GOP took the House, it
promptly called Bernanke in to lecture him about debasing the dollar. Yet
inflation has stayed low, and the dollar has remained strong — just as
Keynesians said would happen.

Yet there hasn’t been a hint of rethinking from leading Republicans; as far
as anyone can tell, they still get their monetary ideas from Atlas Shrugged.

Oh, and this is another reminder to the “market monetarists”, who think that
they can be good conservatives while advocating aggressive monetary
expansion to fight a depressed economy: sorry, but you have no political
home. In fact, not only aren’t you making any headway with the politicians,
even mainstream conservative economists like Taylor and Feldstein are
finding ways to advocate tighter money despite low inflation and high
unemployment. And if reality hasn’t dented this dingbat orthodoxy yet, it
never will.

Friday, June 21, 2013

“The FOMC was more hawkish than we had expected,” economists at Goldman
Sachs concluded after the Wednesday Fed policy meeting, a view
widely held on Wall Street trading floors.

However, a close look at Mr. Bernanke’s press conference comments and Fed
official’s interest-rate projections released after the meeting show the Fed
took several steps aimed at sending the opposite signal.

I am going to add two points. First is that while great pains were taken to
lock up expectations of the path of short-run interest rates, the Fed may be
underestimating the importance of the flow of asset purchases. Federal Reserve
Chairman Ben Bernanke reiterated the Fed's belief that the stock of asset held
is the key variable. Felix Salmon, however,
has the oppostie view:

At his press conference yesterday, Ben Bernanke reiterated his view that
the way QE works is through simple supply and demand: since the Fed is
buying up fixed-income assets, that means fewer such assets to go round for
everybody else, and therefore higher prices on those assets and lower yields
generally. In reality, however, the flow always mattered more than the
stock: when the Fed is in the market every day, buying up assets, that
supports prices more than the fact that they’re sitting on a large balance
sheet. And even more important is the bigger message sent by those
purchases: that we’re in a world of highly heterodox monetary policy, where
the world’s central banks can help send asset prices, especially in the
fixed-income world, to levels they would never be able to reach unaided.

I tend to think that market participants generally favor this view. And why
shouldn't they? The pace of the flow says something about the expected future
stock of the assets. One way to interpret this week's events is that market
participants now see that the stock of assets held by the Fed is reaching its
peak, and while the Fed may not sell those assets, they will let them mature off
the balance sheet.

The second point, which I don't think should be under-emphasized, is that
only one person who was in the room Tuesday and Wednesday has spoken about the
meeting - St. Louis Federal Reserve President James Bullard. And I think he
gave a
pretty clear message:

Policy actions should be undertaken to meet policy objectives, not
calendar objectives.

The Fed shifted toward calendar objectives this week. It is the only way to
reconcile Bernanke's plan for ending QE with the data flow.

N.I.: Is that correct? Is this a more hawkish Fed today than it
was a week ago or a month ago?

J.B.: Based on Wednesday’s action, I would say it is.

Bullard was in the room and concluded the same thing markets concluded: The
Fed shifted in a hawkish direction this week. Bernanke might have tried to
cushion the blow, but you can't avoid the reality that he he laid out a plan to
end QE - and that plan involves a shift toward a calendar component.

It's About The Calendar, by Tim Duy: St. Louis Federal Reserve President James Bullard explained his FOMC dissent
in a press release this morning, and it was an eye-opener. I don't see how
you can read Bullard's statement and not conclude that the primary consideration
for scaling back asset purchases is the calendar. I think that the date, not
the data, is more important than Fed officials like to claim.

Bullard first attacks the Fed's decision in light of falling inflation:

Federal Reserve Bank of St. Louis President James Bullard dissented with
the Federal Open Market Committee decision announced on June 19, 2013.
In his view, the Committee should have more strongly signaled its
willingness to defend its inflation target of 2 percent in light of recent
low inflation readings. Inflation in the U.S. has surprised on the
downside during 2013. Measured as the percent change from one year
earlier, the personal consumption expenditures (PCE) headline inflation rate
is running below 1 percent, and the PCE core inflation rate is close to 1
percent. President Bullard believes that to maintain credibility, the
Committee must defend its inflation target when inflation is below target as
well as when it is above target.

No surprise here; Bullard frequently voices concerns about the path of
inflation and inflation expectations on both sides of the target. The real
action begins with the next sentence:

President Bullard also felt that the Committee’s decision to authorize
the Chairman to lay out a more elaborate plan for reducing the pace of asset
purchases was inappropriately timed. The Committee was, through the
Summary of Economic Projections process, marking down its assessment of both
real GDP growth and inflation for 2013, and yet simultaneously announcing
that less accommodative policy may be in store. President Bullard felt
that a more prudent approach would be to wait for more tangible signs that
the economy was strengthening and that inflation was on a path to return
toward target before making such an announcement.

Bullard's point is a good one. Why would the Fed lay out a plan to withdraw
accommodation - which in and of itself is a withdrawal of accommodation - at a
meeting when forecasts were downgraded? Because, as a group, policymakers are
no longer comfortable with asset purchases and want to draw the program to a
close as soon as possible. And that means downplaying soft data and hanging
policy on whatever good data comes in the door. In this case, that means the
improvement in the unemployment rate forecast. Just for good measure, let's add
on a new policy trigger, a 7% unemployment rate. In my opinion, it is not a
coincidence that they picked a trigger variable where their forecasts have been
most accurate or even too pessimistic. They loaded the dice in their favor.

Bullard then goes one step further:

In addition, President Bullard felt that the Committee’s decision to
authorize the Chairman to make an announcement of an approximate timeline
for reducing the pace of asset purchases to zero was a step away from
state-contingent monetary policy. President Bullard feels strongly
that state-contingent monetary policy is best central bank practice, with
clear support both from academic theory and from central bank experience
over the last several decades. Policy actions should be undertaken to
meet policy objectives, not calendar objectives.

Key words: "calendar objectives." Bullard clearly felt the mood in the room
was something to the effect of "We know the data is soft, but we want out of
this program by the middle of next year, so we are going to lay out a program to
do just that."

In light of Bullard's dissent, the market's reaction should be perfectly
clear. I have seen some twitter chatter to the effect of market participants
didn't understand what Federal Reserve Chairman Ben Bernanke was saying, that
his message was really dovish, that interest rates would be nailed to the zero
bound in 2015, that the policy was data dependent, etc. Market participants
obviously didn't have that interpretation.

Indeed, I think market participants clearly heard Bernanke. After weeks of
being soothed by analysts saying that the data was key, that low inflation would
stay the Fed's hand, Bernanke laid out clear as day a plan for ending
quantitative easing by the middle of next year. Market participants then
concluded exactly what Bullard concluded: It's the date, not the data.

With that information in hand, market participants did exactly what they
should have been expected. I think Felix Salmon
has it right:

What we really saw today was not a move out of stocks, or bonds,
or gold, but rather a repricing within each asset class.

The Fed changed the game this week. Bernanke made clear the Fed wants out of
quantitative easing. While everything is data dependent, the weight has
shifted. The objective of ending quantitative now carries as much if not more
weight than the data. Market participants need to adjust the prices of risk
assets accordingly.

Bottom Line: I think the question is not how good the data needs to be to
convince the Fed to taper. The question is how bad it needs to be to convince
them not to taper. And I think it needs to be pretty bad.

The most significant answer, I’d suggest, is the growing importance of
monopoly rents: profits that ... reflect the value of market dominance. ...

To see what I’m talking about, consider the differences between ... General
Motors in the 1950s and 1960s, and Apple today.

Obviously, G.M. in its heyday had a lot of market power. Nonetheless, the
company’s value came largely from its productive capacity: it owned hundreds
of factories and employed around 1 percent of the total nonfarm work force.

Apple, by contrast, seems barely tethered to the material world..., it
employs less than 0.05 percent of our workers. ... To a large extent, the
price you pay for an iWhatever is disconnected from the cost of producing
the gadget. Apple simply charges what the traffic will bear, and ... the
traffic will bear a lot. ...

I’m not making a moral judgment here. You can argue that Apple earned its
special position — although I’m not sure how many would make a similar claim
for ... the financial industry... But here’s the puzzle: Since profits are
high while borrowing costs are low, why aren’t we seeing a boom in business
investment? ...

Well, there’s no puzzle here if rising profits reflect rents, not returns on
investment. A monopolist can, after all, be highly profitable yet see no
good reason to expand its productive capacity. ...

You might suspect that this can’t be good for the broader economy, and you’d
be right. If household income and hence household spending is held down
because labor gets an ever-smaller share of national income, while
corporations, despite soaring profits, have little incentive to invest, you
have a recipe for persistently depressed demand. I don’t think this is the
only reason our recovery has been so weak — weak recoveries are normal after
financial crises — but it’s probably a contributory factor.

Just to be clear, nothing I’ve said here makes the lessons of history
irrelevant. In particular, the widening disconnect between profits and
production does nothing to weaken the case for expansionary monetary and
fiscal policy as long as the economy stays depressed. But the economy is
changing, and in future columns I’ll try to say something about what that
means for policy.

Thursday, June 20, 2013

I was working on this post Tuesday morning when the phone rang and, to use Paul Krugman's phrase, life intervened. I had something to say about it, but I don't know what it was at this point. Anyway, may as well post it now (posts from me will continue to be sparse/absent for awhile -- immense thanks for the outpouring of support):

According to the plaintiff, Standard & Poor’s catered rating favors in order
to maintain and grow its market share and the fee income generated from
structured debt ratings. In support of these allegations, the complaint lists
internal emails in which Standard & Poor’s analysts complain that analytical
integrity is sacrificed in pursuit of rating favors for the issuer banks.

Standard & Poor’s files for dismissal of the case

Standard & Poor’s denies issuing inflated ratings and any possible conflict
of interest... That some of Standard & Poor’s very own employees appealed to
their colleagues and superiors to withdraw inflated ratings is dismissed as
"internal squabbles" and interpreted as a "robust internal debate among Standard
& Poor’s employees"...

Statistical evidence on rating bias in structured products

While the US Department of Justice did not give any statistical evidence in
its deposition, our new research (Efing and Hau 2013) suggests that rating
favors were indeed systematic and pervasive in the industry.

In a sample of more than 6,500 structured debt ratings produced by Standard &
Poor’s, Moody's and Fitch, we show that ratings are biased in favor of issuer
clients that provide the agencies with more rating business. This result points
to a powerful conflict of interest, which goes beyond the occasional
disagreement among employees.

The beneficiaries of this rating bias are generally the large financial
institutions that issue most structured debt; they in turn provide the rating
agencies with most of their fee income. Better ratings on different components
(so-called tranches) of the debt-issue amount to a lower average yield at
issuance – a cost reduction pocketed by the issuer bank. ...[presents
evidence]...

The evidence also suggests that the two other rating agencies, Moody’s and
Fitch were no less prone to rating favors towards their largest clients than was
Standard & Poor’s. ...

Still more evidence on rating bias in bank ratings

Additional evidence for rating bias emerges for bank ratings. Hau, Langfield
and Marques-Ibanes (2012) show in a paper forthcoming in Economic Policy that
rating agencies gave their largest clients also more favorable overall bank
credit ratings. ...

Hau, Langfield and Marqués-Ibañez (2012) also show that large banks profited
most from rating favors. ... The rating process for banks may have contributed
to substantial competitive distortions in the banking sector, thus fostering the
emergence of the too-big-to-fail banks.

Ironies of the case

It is hard to read some of the legal arguments without being struck by a
sense of irony.

In its defense, Standard & Poor’s argues (without admitting any rating bias)
that it has never made a legally binding promise to produce objective and
independent credit ratings. ... For an agency whose business model is based on
its reputation as an impartial 'gatekeeper' of fixed income markets, this
defense is most remarkable.

But the accusation has its own oddities: Standard & Poor’s argues that it is
impossible to defraud financial institutions about "the likely performance of
their own products". Standard & Poor’s points out the irony "that two of the
supposed 'victims,' Citibank and Bank of America – investors allegedly misled
into buying securities by Standard & Poor’s fraudulent ratings – were the same
huge financial institutions that were creating and selling the very CDOs at
issue"...

In many cases the victim-view on institutional investors may indeed be
questionable: Large banks often issued complex securities and at the same time
invested in them. It is hard to believe that the asset management division of a
bank was ignorant of the dealings by the structured product division with the
rating agencies. ... It is difficult to figure out where exactly the border
between complicity and victimhood runs.

What could be done?

The lawsuit against Standard & Poor’s highlights the conflicts of interest
inherent in the rating business, but can do little to resolve them. If new and
complex regulation and supervision of rating agencies provides a remedy is
unclear and remains to be seen. However, three alternative policy measures could
make the existing conflicts much less pernicious:

Similar to US bank regulation under the Dodd-Frank act, Basel III should
abandon (or at least decrease) its reliance on rating agencies for the
determination of bank capital requirements.

As forcefully argued by Admati, DeMarzo, Hellwig and Pfleiderer (2011),
much larger levels of bank equity as required under Basel III could reduce
excessive risk-taking incentives and ensure that future failures in
bank-asset allocation do not trigger another banking crisis.

More bank transparency in the form of a full disclosure of all bank
asset holdings at the security level would create more informative market
prices for bank equity and debt, with positive feedback effects on the
quality of bank governance and bank supervision.

The story is that the Fed has tended to overestimate the strength of the
economy, and has consequently had to maintain easy policy longer than
policymakers had anticipated. Assuming the Fed continues this pattern of
errors, they may delay the now-anticipated exit from asset purchases. As
monetary policymakers continue to emphasize, policy is data dependent.

But while the growth forecasts have tended to be overly optimistic, the same
is not true for the unemployment forecast. Those forecasts have tended to
move downward over time:

I am sure this difference has not been lost on the Fed, especially if they
have a Phillips Curve view of inflation. I suspect that as unemployment
creeps lower, they will downplay low growth in favor of emphasizing the
importance of low unemployment. This is especially true now that Bernanke
has defined a 7% trigger for ending asset purchases. In short, don't
assume that a failure to meet the growth forecast will hold the Fed's hand.
Watch the unemployment forecast; it may be more important at this point in
the policy cycle.

FOMC Statement: First Reaction, by Tim Duy: The June
FOMC statement was released minutes ago, and it sent a clear signal that the
door to scaling back asset purchases was now wide open. Of course, we still
await the press conference, where Federal Reserve Chairman Ben Bernanke can
place his own spin on the statement, but I suspect we will see him take the
opportunity to set the stage for a policy change as early as September.

However, free, unregulated markets are not always the answer. It’s true that
competitive markets have desirable properties, but
very special conditions must be present for competitive markets to emerge.
When these conditions are not met, as is often the case in the real world,
free markets can perform very poorly. In these cases – as illustrated in the
following examples – government intervention that eliminates troublesome
“market freedoms” can often be used to move these markets closer to the
competitive ideal.

Monday, June 17, 2013

FOMC Meeting Begins Tomorrow, by Tim Duy: This week's FOMC meeting is
shaping up to be quite the event. Not for the actually policy result itself,
which is widely expected to be unchanged, but for the subsequent press
conference with Federal Reserve Chairman Ben Bernanke. The Fed's communication
strategy has clearly unraveled in recent weeks, and Bernanke has an opportunity
to regain control. But will he be able to do so, or will he leave even more
confusion in his wake?

Start with the basics, the statement itself. The Fed is not going to change
the pace of asset purchases this week. Recent Fedspeak has made clear that it
remains too early to reduce monetary accommodation. The statement will probably
be relatively unchanged. I anticipate that they take note of some moderately
weaker data since the last FOMC meeting, as well as lower than anticipated
inflation. Neither, however, is sufficient to drive asset purchases higher. It
will be interesting to how much they emphasize the fiscal contraction. If the
statement shifts to the side of "fiscal contraction appears to be having little
impact on private activity," the implication would be that they are looking
through the fiscal drag on headline GDP numbers. That obviously sets the stage
for reducing asset purchases sooner than later.

Next come the closely watched forecasts. Near-term forecasts for inflation
and perhaps GDP growth may be softer, but also watch the longer-term forecasts
and especially any change in the expected path of unemployment. The latter, I
think, is critical in setting an end to asset purchases - the Fed will want to
be draw QE to a close prior to hitting the 6.5% threshold at which point they
have said they will evaluate rate policy.

Finally comes the press conference. Here is where the real action should
take place. Market participants have become increasingly concerned about ending
asset purchases. I believe that market participants are having trouble
understanding the implications, or lack thereof, of altering the pace of
quantitative easing on interest rate policy. Bernanke will attempt to clear the
way for ending quantitative easing while attempting to divorce that decision
from any subsequent decision on rate hikes.

This, of course, will be easier said than done. I think a critical problem
is that the Fed does not want to be pre-committed to some policy path, but at
the same time does not want to surprise markets. They want to avoid a repeat of
1994, with the sharp spike in yields viewed as a communications failure. They
believed they would resolve this divide by shifting the focus to the data. They
were wrong.

Investors increasingly have focused on predicting the moment the Fed will
start to pull back on its massive stimulus program...

...It’s the type of parlor game the Fed had hoped to avoid. Instead, it
has tried to convince the markets that the date is less important than the
data.

Fed officials deliberately chose not to attach a time frame to their
easy-money policies when developing their forward guidance for the public
last year.

Stop right here. I think it is important to note that Fed policymakers are
the ones who started the ball rolling on the importance of the date over the
data. Specifically, at the beginning of April San Franscisco Federal Reserve
President John Williams
defined a time line for ending QE given the current path of data. At that
point the conversation shifted from data to date. Other policymakers followed
suit.

Does that mean that Williams made an error? Not necessarily. I think it is
impossible to communicate the path of policy without making market participants
aware of the associated timeline. Once you describe your view of the data and
your forecast, by default you will define the expected time for the policy
change. In effect, the Fed can't have it both ways. They can't jointly pretend
the date doesn't matter while at the same time clearly communicating the path of
policy. If they don't communicate the path/timing, then the eventual policy
move will trigger an overreaction. If they do communicate the path/timing, but
don't explain how that path fits in the context of the data, then they also risk
an overreaction.

The latter is the position they now find themselves in. Williams let the cat
out of the bag, that the Fed had a timeline in mind. But it is challenging to
see how the data fits into the time line. Back to Mui:

The goal was to help investors come to better conclusions on their own by
revealing the public data that Fed officials use as guideposts. In theory,
that means interest rates would hew more closely to incoming data than to
Fed pronouncements.

But, as it turns out, there are many ways to parse the numbers.

“They kind of threw out these conditions,” said Michael Feroli, chief
U.S. economist at JPMorgan. “They’re telling us something but not telling us
something.”

Honestly, it is difficult to make the case for ending asset purchases on the
data alone. It is neither clear that the labor market is stronger and
sustainable nor that asset purchases should be cut in the face of falling
inflation. In fact, I think you can argue that the Fed is moving the goalposts
to some less defined objective. As noted above, I think the path of the
unemployment rate plays a role. But so too does financial stability concerns.
And also general discomfort on the part of policymakers about the size of the
balance sheet. Indeed, the December conversion from Operation Twist to asset
purchases may have been simply insurance against a fiscal disaster that did not
materialize. Ultimately, the shift to tapering talk was too abrupt given the
data, and that raises the possibility that some undisclosed factor is at work.

Now, if we don't understand what is driving the decision to scale back asset
purchases, then it is likely we also don't understand how the data will impact
subsequent interest rate decisions. Again, back to Mui:

Part of the problem has been muddy economic data that do not provide a
clear signal of where the recovery is headed. The Fed also has left itself
plenty of wiggle room to interpret the data. It did not define what
“substantial improvement” would be required to dial back its
$85 billion-a-month in bond purchases, and it has suggested that it could
leave interest rates untouched even after its unemployment or inflation
thresholds are met.

If the Fed's plans for ending quantitative easing are opaque relative to the
data, then what is are we to expect when the unemployment threshold approaches.
An equally opaque policy response? Is the Fed going to change the goalposts
again? When does it shift from unemployment and inflation to concerns about
financial stability? And how do they propose to pretend that you can commit to
some data dependent path without implying a related time line?

Bottom Line: This FOMC meeting is about the Fed regaining - or further
losing - control over its communication strategy. Bernanke will attempt to
detail how exactly the data flow is supportive of scaling back asset purchases
in the next few months (I believe the Fed prefers September) while at the same
time disassociating asset purchases from interest rate policy. I think it is
important that market participants believe that the shift to tapering talk was
entirely data dependent and not influenced by some other factors. Otherwise,
they will doubt the supposed data dependent thresholds for rate policy. And the
Fed is going to have to come to terms with the reality that the instant they
start to anticipate a change in policy, they start a clock ticking. Making the
distinction between date and data is not as easy as it sounds.

Why are we so worried about highly uncertain budget projections extending decades into the future when we have very real problems such as high levels of unemployment that need our immediate attention?

Fight the Future, by Paul Krugman, Commentary, NY Times: Last week the
International Monetary Fund, whose normal role is that of stern
disciplinarian to spendthrift governments,... argued that the sequester and
other forms of fiscal contraction will cut this year’s U.S. growth rate by
almost half, undermining what might otherwise have been a fairly vigorous
recovery. And these spending cuts are both unwise and unnecessary.

Unfortunately, the fund apparently couldn’t bring itself to break completely
with the austerity talk that is regarded as a badge of seriousness in the
policy world. Even while urging us to run bigger deficits for the time
being, Christine Lagarde, the fund’s head, called on us to “hurry up with
putting in place a medium-term road map to restore long-run fiscal
sustainability.”

So here’s my question: Why, exactly, do we need to hurry up? Is it urgent
that we agree now on how we’ll deal with fiscal issues of the 2020s, the
2030s and beyond?

No, it isn’t. And in practice, focusing on “long-run fiscal sustainability”
— which usually ends up being mainly about “entitlement reform,” a k a cuts
to Social Security and other programs — isn’t a way of being responsible. On
the contrary, it’s an excuse, a way to avoid dealing with the severe
economic problems we face right now.

What’s the problem with focusing on the long run? Part of the answer ... is
that the distant future is highly uncertain (surprise!)... In particular,
projections of huge future deficits are to a large extent based on the
assumption that health care costs will continue to rise substantially faster
than national income — yet the growth in health costs has slowed
dramatically in the last few years, and the long-run picture is already
looking much less dire...

When will we be ready for a long-run fiscal deal? My answer is, once voters
have spoken decisively in favor of one or the other of the rival visions
driving our current political polarization. Maybe President Hillary Clinton,
fresh off her upset victory in the 2018 midterms, will be able to broker a
long-run budget compromise with chastened Republicans; or maybe demoralized
Democrats will sign on to President Paul Ryan’s plan to privatize Medicare.
Either way, the time for big decisions about the long run is not yet.

And because that time is not yet, influential people need to stop using the
future as an excuse for inaction. The clear and present danger is mass
unemployment, and we should deal with it, now.

Sunday, June 16, 2013

Don’t Blame the Work Force, Editorial Board, NY Times: There is a
durable belief that much of today’s unemployment is rooted in a skills gap,
in which good jobs go unfilled for lack of qualified applicants. This is
mostly a corporate fiction, based in part on self-interest and a misreading
of government data.

A Labor Department report last week showed 3.8 million job openings in the
United States in April — proof, to some, that there would be fewer
unemployed if more people had a better education and better skills. But both
academic research and a closer look at the numbers in the department’s Job
Openings and Labor Turnover Survey show that unemployment has little to do
with the quality of the applicant pool. ... [presents numbers and research]
...

If a business really needed workers, it would pay up. That is not happening,
which calls into question the existence of a skills gap as well as the
urgency on the part of employers to fill their openings. Research from
the National Bureau of Economic Research found that “recruiting intensity” —
that is, business efforts to fill job openings — has been low in this
recovery. Employers may be posting openings, but they are not trying all
that hard to fill them, say, by increasing job ads or offering better pay
packages.

Corporate executives have valuable perspectives on the economy, but they
also have an interest in promoting the notion of a skills gap. They want
schools and, by extension, the government to take on more of the costs of
training workers that used to be covered by companies as part of on-the-job
employee development. They also want more immigration, both low and high
skilled, because immigrants may be willing to work for less than their
American counterparts.

There are many reasons to improve education, to welcome immigrants and to
advance other policies aimed at transforming the work force and society. But
a skills gap is not among them. Meeting today’s job challenges requires
action to improve both the economy and pay, including government measures to
create jobs, strengthen health and retirement systems, and raise the minimum
wage. Fretting about a skills gap that does not exist will not help.

On the "If a business really needed workers, it would pay up" and "recruiting intensity" statements
above, here's a rerun of a
post of mine on this topic (this is from 2011):

... With all the talk about whether our unemployment problem is cyclical or
structural (I believe it's mostly cyclical), many people are looking at
measures of mismatches to assess how much of the problem is structural. But
care needs to be taken in the interpretation of mismatch numbers. Here's
why.

Suppose that you run a business in Town A and you need someone to run a
complicated piece of equipment. Unfortunately, the size of your town is
relatively moderate, and there are no qualified job applicants available.
You have advertised the job for weeks, but no takers. This sounds like a
classic case of structural unemployment -- there is a need for workers with
a different skill set -- but it may not be a structural problem.

Suppose also that the economy is in a recession, and business has not been
good. Because of that, you can't offer a very high wage. It turns out that
in the very next town, Town B, there is a qualified worker who was laid off
due to a business failure caused by the recession, but at the wage you are
offering the worker is not willing to move. The worker has a job and is
surviving, though the pay is much less than before and the worker is
underemployed -- the worker is mismatched -- but the family is getting by.

However, if things were better -- if the economy was humming away at full
employment -- the employer in Town A could offer a higher wage and induce
the worker in Town B to move. If this is the case, then this unemployment is
cyclical, not structural. There is a mismatch, but the mismatch is driven by
lack of demand.

The point is that when we talk about structural unemployment, we assume
aggregate demand is not the problem. Thus, structural unemployment must be
measured under an assumption that demand is sufficient to return us to full
employment. ... If an increase in demand will fix the problem, as in the
example above, then it's not a structural problem.

The bottom line is that to measure structural unemployment in a recession,
it's not enough to simply survey the labor market and count the mismatches.
You have to know if those mismatches would persist at a level of demand
consistent with full employment. To the extent that the mismatch problem is
due to lack of demand, and wages and prices that are too low to induce
resource movements to their best use, the problem is cyclical, not
structural.

The House voted overwhelmingly to let the measure – labeled the London Whale
Loophole Act by critics – pass. It's one of several measures that the House
has taken to weaken oversight of derivatives; the other two will come up for
debate soon.

It will surprise no cynic that there is a financial connection between the
members of Congress who approve these measures and the industry they are
supposed to regulate. According to MapLight:

"On average, House agriculture committee members voting for HR 992 [one of
the derivatives bills] have received 7.8 times as much money from the top
four banks as House agriculture committee members voting against the bill."

It's no surprise, of course – given the well-known influence of Wall Street
in writing and influencing the bills that regulate Wall Street. Citigroup
lobbyists infamously drafted 70 lines of an 85-line amendment that protected
a large acreage of derivatives from regulation.

There is more to add. ... [adds more] ...

All of this is part of the process of killing off the one flailing, pathetic
attempt at financial reform: the Dodd-Frank Act. Dodd-Frank, bloated and
vague from the beginning, was never a threat to Wall Street. Big banks
thought they could wait out the outrage, then start undermining the intent
of the law.

They were right, this time. But when they're wrong – and when those
derivatives cause another crisis – it'll be Americans who pay the price.

Saturday, June 15, 2013

What Sweden Can Tell Us About Obamacare, by Robert Frank, Commentary, NY
Times: Last month, for the 37th time, the House of Representatives voted
to repeal Obamacare, with many Republicans saying that its call for greater
government involvement in the health care system spells doom. Yet most other
industrial countries have health care systems with far more government
involvement than we are ever likely to see under Obamacare. What does their
experience tell us about Republican fears?

While in Sweden this month as a visiting scholar, I’ve asked several Swedish
health economists to share their thoughts about that question. They have
spent their lives under a system in which most health care providers work
directly for the government. Like economists in most other countries, they
tend to be skeptical of large bureaucracies. ...

Yet none of them voiced ... complaints about recalcitrant bureaucrats...
Little wonder. The Swedish system performs superbly, and my Swedish
colleagues cited evidence of that fact with obvious pride. ...

Congressional critics must abandon their futile efforts to repeal Obamacare
and focus instead on improving it. Their core premise — that greater
government involvement in health care provision spells disaster — lacks
support in the wealth of evidence from around the world that bears on it.

The truth appears closer to the reverse: Because of pervasive market
failures in private health care markets, this may be the sector that
benefits most from collective action.

In its annual check of the health of the U.S. economy, the IMF forecast
economic growth would be a sluggish 1.9 percent this year. The IMF estimates
growth would be as much as 1.75 percentage points higher if not for a rush
to cut the government's budget deficit. ...

"The deficit reduction in 2013 has been excessively rapid and ill-designed,"
the IMF said. "These cuts should be replaced with a back-loaded mix of
entitlement savings and new revenues."

The Fund recommended that the U.S. Federal Reserve keep up its massive asset
purchases at least through the end of the year to support the U.S. recovery,
but should also prepare for a pull-back in the future. ...

The recovery of output and employment didn't have to be so slow. I'm not
saying that reversing these policies (or replacing them with more aggressive
fiscal policy measures) would have brought miracles, it was going to be a
difficult recovery no matter what polices we pursued. But we certainly could
have done better than we did, particularly on the fiscal policy front.